Posts Tagged ‘Budget Process’

The House recently changed the rules of budget scoring: The Congressional Budget Office and the Joint Committee on Taxation will now account for macroeconomic effects when estimating the budget impacts of major legislation. Here are three things you should know as we await the first official dynamic score.

1. Spending and regulations matter, not just taxes

You might think dynamic scoring is just about taxes. It’s not. Spending and regulatory policies can also move the economy. Take the Affordable Care Act. CBO estimates that the law’s insurance subsidies will reduce labor supply by 1.5 to 2.0 percent from 2017 to 2024, some 2 to 2.5 million full-time equivalent workers. If CBO and JCT do a dynamic score of the House’s latest ACA repeal, this effect will be front and center.

The same goes for immigration reform. In 2013 (and in 2006), CBO and JCT included some macroeconomic effects in their score of comprehensive immigration reform, though they did not do a fully dynamic score. Under today’s rules, reform would show an even bigger boost to the economy and more long-term deficit reduction than the agencies projected in the earlier bills.

2. Dynamic scoring isn’t new

For more than a decade, CBO and JCT have published dynamic analyses using multiple models and a range of assumptions. For example, JCT projected former House Ways & Means Committee chairman Dave Camp’s tax reform plan would boost the size of the economy (not its growth rate) by 0.1 to 1.6 percent over 2014 to 2023. The big step in dynamic scoring will be winnowing such multiple estimates into the single set of projections required for official scores.

Observers understandably worry about how the scorekeepers will do that. For example, what will JCT and CBO do with certain forward-looking models that require assumptions not just about the policy in question but also about policy decisions Congress will make in the future? If the agencies score a tax cut today, do they also have to include future tax increases or spending cuts to pay for it, even if Congress doesn’t specify them? If so, how should the agencies decide what those offsetting policies are? Does the existence of such models undermine dynamic scoring from the start?

Happily, we already have a good sense of what the agencies will do, and no, the existence of such models doesn’t hamstring them. At least twice a year, CBO and JCT construct baseline budget projections under existing law. That law often includes scheduled policy changes, most notably the (in)famous “fiscal cliff” at the end of 2012. CBO and JCT had to include the macro effects of the cliff in their budget baseline at that time, even though they had no idea whether and how Congress might offset those policies further in the future. That’s dynamic scoring in all its glory, just applied to the baseline rather than analyzing new legislation. CBO and JCT didn’t need to assume hypothetical future policies to score the fiscal cliff, and they won’t need to in scoring legislation either.

3. Dynamic scoring won’t live up to the hype, on either side

Some advocates hope that dynamic scoring will usher in a new era of tax cuts and entitlement reforms. Some opponents fear that they are right.

Reality will be more muted. Dynamic scores of tax cuts, for example, will include the pro-growth incentive effects that advocates emphasize, leading to more work and private investment. But they will also account for offsetting effects, such as higher deficits crowding out investment or people working less because their incomes rise. As previous CBO analyses have shown, the net of those effects often reveals less growth than advocates hope. Indeed, don’t be surprised if dynamic scoring sometimes shows tax cuts are more expensive than conventionally estimated; that can easily happen if pro-growth incentives aren’t large enough to offset anti-growth effects.

Detractors also worry that dynamic scoring is an invitation for JCT or CBO to cherry pick model assumptions to favor the majority’s policy goals. Doing so runs against the DNA of both organizations. Even if it didn’t, the discipline of twice-yearly budget baselines discourages cherry picking. Neither agency wants to publish rosy dynamic scenarios that are inconsistent with how they construct their budget baselines. You don’t want to forecast higher GDP when scoring a tax bill enacted in October, and have that GDP disappear in the January baseline.

I am cautiously optimistic about dynamic scoring. Done well, it can help Congress and the public better understand the fiscal effects of major policies. There are still some process issues to resolve, most notably how investments might be handled, but we should welcome the potential for better information.

For more views, see the dynamic scoring forum at TaxVox, the blog of the Tax Policy Center.

Lending programs create special challenges for federal budgeting. So special, in fact, that the Congressional Budget Office estimates their budget effects two different ways. According to official budget rules, taxpayers will earn more than $200 billion over the next decade from new student loans, mortgage guarantees, and the Export-Import Bank. According to an alternative that CBO favors, taxpayers will lose more than $100 billion.

Those competing estimates pose a $300 billion question: Which budgeting approach is best?

As I document in a new report and policy brief, the answer is neither one. Each approach tells only part of the story. Congress would be better served by a new approach that fairly reflects all the fiscal effects of lending.

Compared with what?

If lending programs perform as CBO expects, they will bring in new money that the government can use to reduce the deficit, increase spending, or cut taxes. In that sense, taxpayers may come out more than $200 billion ahead.

But these programs do not fully compensate taxpayers for their financial risk. If the government took the same risk by making loans and guarantees at fair market rates—perhaps by investing in publicly traded bonds—taxpayers would make much more. Taxpayers are subsidizing the students, homeowners, and companies that borrow through these programs. In that sense, taxpayers come out more than $100 billion behind.

The same issue can arise in personal life. Suppose your aunt asks for a $10,000 loan to start a business. You’ve got exactly that much in a government bond fund earning 2.5 percent, and she offers to pay 5 percent. She’s got a good head for business, so the risk of default is very low; realistically you expect a 4 percent annual return.

The loan sounds like a winner, right? Her 4 percent beats the bond fund’s 2.5 percent, if you can handle the risk. But there’s one other thing: your brother-in-law, equally good at business, would like a similar loan, and he’s willing to pay 6 percent, with an expected net of 5 percent.

Now the loan to your aunt sounds like a loser. Your brother-in-law’s 5 percent beats her 4 percent. You might still prefer to lend to her, but you would come out behind in financial terms.

The competing CBO estimates reflect this dichotomy. One approach compares the financial returns of lending with doing nothing (the $200 billion gain in CBO’s case, 4 percent versus 2.5 percent in yours). The other compares the returns with taking similar risks and being fully compensated (the $100 billion loss in CBO’s case, 4 percent versus 5 percent in yours).

Both comparisons provide useful information. If you want to predict the government’s future fiscal condition, you should compare the financial returns of lending with doing nothing. If you want to measure the subsidies given to borrowers, you should compare returns with the fair market alternative.

When you discuss your aunt’s proposal with your spouse, you would be wise to mention not only the potential financial gain (“4 percent is better than 2.5 percent”) but the subsidy to your aunt (“4 percent is less than the 5 percent your brother would pay”). Only then can you have an open discussion of your family’s financial priorities.

Today’s approaches

The same information is necessary for an open discussion of federal budgeting. But official budget rules, created by the Federal Credit Reform Act of 1990 (FCRA), require CBO to use just the first approach in its budget analyses. Official estimates thus measure the fiscal effects of lending, not the subsidies provided to borrowers. CBO rightly believes, however, that policy deliberations are incomplete without measuring the subsidies, which CBO calculates separately using an approach known as fair value.

Policy analysts have vigorously debated the pros and cons of FCRA and fair value for years. Neither side has scored a decisive win for a simple reason: both approaches are incomplete. Fair value measures subsidies well, but tells us nothing about fiscal effects; this is its missing-money problem. FCRA measures lifetime fiscal effects well, but tells us nothing about subsidies.

By recording expected fiscal gains the moment a loan is made, moreover, FCRA makes lending appear to be a magic money machine. Lending may pay off over time, but the gains do not happen the moment the loan’s ink is dry. Like any lender, the government must be patient to earn those returns. It must hold the loan, perhaps for many years, and bear the associated financial risk.

A better approach

For those reasons, I believe we should replace both approaches with a more accurate budgeting method, which I call expected returns. As the report and brief describe, the expected-returns approach forecasts the fiscal effects of a loan by projecting the government’s expected returns year by year, rather than collapsing them into a single value at the time the loan is made, as both FCRA and fair value do.

Expected returns accurately tracks the fiscal effects of lending over time, thus avoiding both fair value’s missing-money problem and FCRA’s magic-money-machine problem. It also provides a natural framework for reporting the fiscal effects of lending and the subsidies to borrowers. Expected returns would give policymakers and the public a more accurate assessment of federal lending than either of the approaches we use now.

Congressional negotiators are trying to craft a budget deal by mid-December. Fareed Zakaria’s Global Public Square asked twelve experts what they hoped that deal would include. My suggestion: it’s time to fix the budget process:

Odds are slim that the budget conference will deliver anything big on substance. No grand bargain, no sweeping tax reform, no big stimulus paired with long-term budget restraint. At best, conferees might replace the next round of sequester cuts with more selective spending reductions spread over the next decade.

Those dim substantive prospects create a perfect opportunity for conferees to pivot to process. In principle, Congress ought to make prudent, considered decisions about taxes and spending programs. In reality, we’ve lurched from the fiscal cliff to a government shutdown to threats of default. We make policy in the shadow of self-imposed crises without addressing our long-run budget imbalances or near-term economic challenges. Short-term spending bills keep the government open – usually – but make it difficult for agencies to pursue multiyear goals and do little to distinguish among more and less worthy programs. And every few years, we openly discuss default as part of the political theater surrounding the debt limit.

The budget conferees should thus publicly affirm what everyone already knows: America’s budget process is broken. They should identify the myriad flaws and commit themselves to fixing them. Everything should be on the table, including repealing or replacing the debt limit, redesigning the structure of congressional committees, and rethinking the ban on earmarks.

Conferees won’t be able to resolve those issues by their December 13 deadline. But the first step to recovery is admitting you have a problem. The budget conferees should use their moment in the spotlight to do so.

P.S. Other suggestions include investing in basic research, reforming the tax system, and slashing farm programs. For all twelve, see here.

Today I had the chance to testify before the Joint Economic Committee about a perennial challenge, the looming debt limit. Here are my opening remarks. You can find my full testimony here.

I’d like to make six points about the debt limit today.

First, Congress must increase the debt limit.

Failure to do so will result in severe economic harm. Treasury would have to delay billions, then tens of billions, then hundreds of billions of dollars of payments. Through no fault of their own, federal employees, contractors, program beneficiaries, and state and local governments would find themselves suddenly short of expected cash, creating a ripple effect through the economy. A prolonged delay would be a powerful “anti-stimulus” that could easily push our economy back into recession.

In addition, there’s a risk that we might default on the federal debt. I expect that Treasury will do everything it can to make debt-service payments on time, but there is a risk that it won’t succeed. Indeed, we have precedent for this. In 1979, Treasury accidentally defaulted on a small sliver of debt in the wake of a debt limit showdown. That default was narrow in scope, but financial markets reacted badly, and interest rates spiked. If a debt limit impasse forced Treasury to default today, the results would be more severe. Interest rates would spike, credit would tighten, financial institutions would scramble for cash, and savers might desert money market funds. Anyone who remembers the financial crisis should shudder at the prospect of reliving such disruptions.

Second, Treasury doesn’t have any “super-extraordinary” measures if the debt limit isn’t raised in time.

Pundits have suggested that Treasury might sidestep the debt limit by invoking the 14th Amendment, minting extremely large platinum coins, or selling gold and other federal assets. But Administration officials have said that none of those strategies would actually work.

Third, debt limit brinksmanship is costly, even if Congress raises the limit at the last minute.

As we saw in 2011, brinksmanship increases interest rates and federal borrowing costs. The Bipartisan Policy Center—building on work by the Government Accountability Office—estimates that crisis will cost taxpayers almost $19 billion in extra interest costs.

Brinksmanship also increases uncertainty, reduces confidence, and thus undermines the economy. In 2011, for example, consumer confidence and the stock market both plummeted, while measures of financial risk skyrocketed.

Finally, brinksmanship weakens America’s global image. The United States is the only major nation whose leaders talk openly about self-inflicted default. At the risk of sounding like Vladimir Putin, such exceptionalism is not healthy.

Deficits have fallen sharply in the past few years. But current budget policies would still create an unsustainable trajectory of debt in coming decades. Congress should address that problem. But the near-term fiscal priorities are funding the government and increasing the debt limit.

Finally, Congress should rethink the debt limit and the entire budget process.

Borrowing decisions cannot be made in a vacuum, separate from other fiscal choices. America borrows today because this and previous Congresses chose to spend more than we take in, sometimes with good reason, sometimes not. If Congress is concerned about debt, it needs to act when it makes those spending and revenue decisions, not months or years later when financial obligations are already in place. When the dust settles on our immediate challenges, Congress should re-examine the entire budget process, seeking ways to make it more effective and less susceptible to dangerous, after-the-fact brinksmanship.

The balanced budget amendment introduced by Senate Republicans yesterday contains a striking error. As written, it would limit federal spending much more than they claim or, I suspect, intend (I said the same back in 2011, when this first came up).

The senators want to balance the budget by limiting spending rather than raising tax revenues. They thus propose the following, according to a press release from sponsor Senator John Cornyn:

Requirement to Balance the Budget. With limited exceptions, the federal budget must be balanced.

Presidential Requirement to Submit a Balanced Budget. Prior to each fiscal year, the President must submit to Congress a balanced budget that limits outlays to 18 percent of GDP.

That 18 percent figure is in line with average tax revenues over the past four decades, but well below average spending, which has been about 21 percent.

So what’s the error? The way the amendment would implement the spending limit:

Total outlays for any fiscal year shall not exceed 18 percent of the gross domestic product of the United States for the calendar year ending before the beginning of such fiscal year, unless two-thirds of the duly chosen and sworn Members of each House of Congress shall provide by law for a specific amount in excess of such 18 percent by a roll call vote. (Emphasis added.)

The amendment thus doesn’t limit spending to 18 percent of the current fiscal year’s GDP; it limits it to 18 percent of GDP in the previous calendar year.

At first glance that may not sound like much. But it works out to be 21 months during which inflation and real growth will almost always be boosting GDP. For example, fiscal 2014 starts in October of this year. If the amendment were effective today, spending would be limited to 18 percent of last year’s GDP—that’s calendar 2012, which started (of course) in January 2012.

That 21-month lag has a big effect on the spending limit. Consider fiscal 2018, the first year it could conceivably take effect (because of a waiting period in the amendment). The Congressional Budget Office projects that nominal GDP that year will be $20.9 trillion. So the Republicans’ fiscal 2018 spending limit ought to be 18 percent of that, a bit less than $3.8 trillion. But the amendment would look back to calendar 2016 to set the limit. CBO estimates that year’s GDP at roughly $19.1 trillion, nearly $2 trillion less than for fiscal 2018. The amendment would thus limit fiscal 2018 spending to a bit more than $3.4 trillion. That’s only 16.4 percent of GDP that year, about $330 billion less than the Republicans’ stated goal.

If you do the same math for the remaining years in CBO’s latest outlook, fiscal 2019 through 2023, that gap never falls below $300 billion.

The same drafting error came up when GOP senators introduced a balanced budget amendment in 2011. When I wrote about it then, several commentators suggested that perhaps it wasn’t an error, but rather a sneaky way to try to limit spending even further. I am not so cynical. Drafting a spending target based on GDP isn’t easy, since you don’t know what future GDP will be. So I can understand why someone drafting this might try to use a measure of GDP that’s already known, albeit subject to much revision. But they goofed.

It’s disappointing that no one has fixed this error in the intervening 18 months. I am not a fan of an arbitrary constitutional limit on spending—even with a supermajority escape valve—but as a fan of arithmetic, let me offer one simple approach: use a GDP forecast from whatever entity is responsible for the spending forecast. For the president’s budget submission, that would be the Office of Management and Budget, and for the congressional process it would be either CBO or the House and Senate Budget Committees. That would make the GDP forecast even more politically sensitive, of course, but it’s better than a formula that misses its intended target by $300 billion each year.

Today I had the chance to testify before the Select Revenue Measures Subcommittee of the House Ways and Means Committee about a perennial challenge, the “tax extenders,” which really ought to be known as the “tax expirers.” Here are my opening remarks. You can find my full testimony here.

As you know, the United States faces a sharp “fiscal cliff” at yearend when numerous policy changes occur. If all these changes happen, they will reduce the fiscal 2013 deficit by about $500 billion, according to the Congressional Budget Office, before taking into account any negative feedback from a weaker economy. About one-eighth of that “cliff”—$65 billion—comes from the expiring and expired tax cuts that are the focus of today’s hearing.

In deciding their fate, you should consider the larger problems facing our tax system. That system is needlessly complex, economically harmful, and widely perceived as unfair. It’s increasingly unpredictable. And it fails at its most basic task, raising enough money to pay our bills.

The “expirers” often worsen these problems. They create uncertainty, complicate compliance, and cost needed revenue. Some make the tax code less fair, some more fair. Some weaken our economy, while others strengthen it.

Fundamental tax reform would, of course, be the best way to address these concerns. But such reform isn’t likely soon.

So you must again grapple with “the expirers.” As a starting point, let me note that they come in three flavors:

Tax cuts enacted to address a temporary challenge such as recession, the housing meltdown, or regional disasters.

Tax cuts that have reached a sunset review. Prolonged economic weakness and recent omnibus extensions mean there aren’t that many of these, but they do exist.

Tax cuts that expire to game budget rules. These appear to be the most common. Supporters intend these provisions to be long-lived or permanent, but they haven’t found the budget resources to do so.

To determine which of these policies should be extended and which not, you should consider several factors:

Does the provision address a compelling need for government intervention?

Does it accomplish its goal effectively and at reasonable cost?

Does it make the tax code more or less fair?

Do its potential benefits justify the revenue loss or the need for higher taxes elsewhere?

In short, you should subject these provisions to the same standards applied to other policy choices. And in this case, you should keep in mind that most of the so-called “tax extenders” are effectively spending through the tax code. You should thus hold them to the same standards as equivalent spending programs.

You should also reform the way you review expiring tax provisions.

Flip the burden of proof. Today’s standing presumption is that most of these provisions will ultimately be extended. That’s why they are called “the extenders,” even after they have expired. Ultimately, though, we should move to a system in which the presumption, rebuttable to be sure, is that expiring provisions will expire unless supporters can justify their continuation. In short, they should be “the expirers.”

Second, divide them up. Like musk oxen, the beneficiaries of these provisions have realized that there is safety in numbers. They thus do their best to coalesce as a single herd—“the extenders”—and to migrate across the annual legislative tundra with as little individual attention as possible.You should break up the herd. Reviewing each provision in detail may not be practical in a single year, but you can identify specific groups for careful review. For example, you can separate out the stimulus provisions, the charity provisions, the energy provisions, and so on.You should also spread scheduled expirations out over time. If fewer expire each year, you will be able to give each one more attention.

Third, change budget rules for temporary tax cuts. Pay-as-you-go budgeting creates crucial discipline but has an unfortunate side effect: long-term tax policies often get chopped into one-year segments. In addition, 10 years of offsets can be used to pay for a single-year extension.To combat this, you could require that any temporary tax provision be assumed to last no less than five years in the official budget baseline. Proponents would then have to round up enough budget offsets to pay for those five years.In addition, Congress could require that offsets happen over the same years as an extension. That would eliminate situations in which 10 years of offsets pay for a single-year extension.

Medicare Part A is one of several federal programs that control spending through a “belt and suspenders” combination of regular program rules (the belt) and an overall limit (the suspenders). But it’s the only one that allows legislated savings to offset the costs of policy changes in other programs and extend the time before the overall limit constrains operations.

Congress can’t increase Social Security payroll taxes to pay for increased health care spending or reduce flood insurance subsidies to pay for tax cuts; in both cases, the resources stay within the affected programs. And when it cuts spending on Medicare Parts B and D to pay for other spending, no one claims those cuts will also postpone the day when trust fund exhaustion will disrupt their operations.

Such double counting is possible only in Medicare Part A. And it’s a real problem, creating needless confusion and reinforcing the sense that Washington plays fast and loose with budget numbers.

Happily, Congress knows how to fix this problem. All it needs to do is apply to Medicare A the practices used by one of the other programs that have “belt and suspenders” budgeting but avoid potential double counting.

One approach would be the rules used by the National Flood Insurance Program. As I discussed in more detail last week, those rules require that any legislated savings remain in the program. Lawmakers can’t reduce NFIP subsidies to pay for new spending in other programs. Instead, any savings are automatically earmarked to pay future NFIP claims that would go unpaid because of the program’s borrowing limit. (For an example, see here.)

This approach brings the overall limit explicitly into the budget. But it makes for weird budgeting. For example, the budget baseline would show Medicare A breaking even over the long run, since the trust fund limit would take precedence over its fundamental deficits.

A better approach would adopt the rules used by Social Security. Those rules show Social Security running deficits far into the future in the budget baseline, but they still take the trust fund seriously when examining new legislation. Any proposed cuts to the program’s spending or increases in its revenues are “off budget”. The Congressional Budget Office reports them, but Congress can’t use them to pay for other spending.

A recent Senate bill provides a telling example. The bill would expand the type of income subject to payroll taxes in order to pay for a one-year extension of low interest rates on student loans. Those low rates would cost $6 billion, but the Senate proposal would raise $9 billion. The bill had to overshoot that much because $3 billion comes from higher Social Security taxes and is thus off limits. Meanwhile, the $6 billion in usable revenues comes from Medicare Part A, which is considered “on budget” despite having a trust fund just like Social Security’s.

That difference highlights the inconsistency in current budgeting. If policymakers believe the Part A trust fund is as sacrosanct as Social Security’s, they should provide the same budgetary protection: Part A savings should be off budget, where they couldn’t be used to pay for health reform, student loans, tax cuts, or anything else outside the hospital insurance program.

If Congress doesn’t believe the trust fund deserves that protection, it should adopt a third approach: make the Part A fund as operationally toothless as the one for Medicare B and D. Those programs spend much more than they receive, so their trust fund has unlimited ability to draw on general revenues. If the same were true for Medicare Part A, program changes could be used to pay for health reform (as they were in 2010) or anything else, just like any other mandatory program. But we wouldn’t have any confusion over whether those changes also extend the program’s ability to operate.

The Social Security and Medicare B and D approaches both make more sense than the mishmash that applies to Medicare A today. I think the Medicare B and D approach is the better of the two, not least because it would put all the parts of Medicare on equal footing. But one could certainly argue for the Social Security approach instead. That’s the discussion we should have now so that we can avoid needless double-counting debates in the future.

P.S. Several readers noted an important qualification to my Social Security discussion in my earlier post. Many experts believe past Social Security surpluses have been used to finance deficits in the rest of the budget and, as a result, Social Security resources have been paying for higher spending or lower revenues elsewhere in government. I agree. My comments in these posts apply only to explicit budgeting decisions, like those in 2010’s health reform or today’s student loan legislation. In that context, Social Security savings cannot be legislatively used to pay for other programs. But they still might have indirect effects. For example, by reducing future unified budget deficits, Social Security savings might weaken future congressional efforts to reduce deficits outside Social Security.